Nov 07 2009
GDP Made Simple
Published by Steve Latter at 8:48 pm under Economic Growth,GDP,Macroeconomics
Just a few weeks ago, the U.S. Government’s Commerce Department provided its first estimate of the country’s 3rd quarter (July-September 2009) gross domestic product or GDP, announcing an estimated annualized quarter over quarter growth of 3.5%. GDP reports are of special interest to countries since they provide an important macroeconomic measurement of how much an economy’s goods & services supply and income has grown, or recessed, compared to the last three calendar months.
Let me try and make the concept of GDP easy to understand and why it is considered perhaps the most important, single macroeconomic measurement.
GDP is simply a calculation that measures the market value (final price) of all the final goods and services produced within the borders of our country. Thus, U.S. GDP includes Toyotas produced in Alabama but excludes Cadillac’s made in Canada. GDP includes all U.S. exports but excludes all U.S. imports since imports, by definition, imports are produced in some other country and are a more direct employment benefit of the foreign country’s GDP.
If you think about it, ultimately our country’s economic satisfaction is best measured by the goods and services that are produced and that we have access to, which is why GDP is the measurement that is synonymous with “economic growth” or growth in goods & services for its citizens. In addition, rising GDP (more goods and services) is the ultimate economic goal of any economy which can best be accomplished through the means of the two other key macroeconomic measurements of employment and productivity, which are not the subject of this particular blog.
Let’s describe how the GDP calculation is made. Each quarter, the Government compares the final value of the domestic goods produced and services rendered in the current quarter to the final value of the goods produced and services rendered in the previous quarter. The calculation then takes the percentage gain, current quarter versus previous quarter, and annualizes the percentage. The comparison is always restated for inflation so that the figures are comparable from one period to the next. For purists, we call this “real GDP” which is the only GDP reported by the media, even though the word “real” is almost always dropped to avoid confusion with the average citizen. For example, the third quarter 2009 U.S. GDP report highlighted a 3.5% GDP annualized growth rate. This means that the second quarter final value of goods and services produced was approximately .87% or 3.5%/4.
Now let me get to my favorite point on GDP, which even many economists lose sight of. GDP growth is precisely the same as income growth! For example, in the second quarter of 2009 we can say that incomes for American households and American citizens grew by 3.5% restated for inflation. Said another way, our country’s purchasing power grew by 3.5% which represents the income to produce the increasing supply of goods and services. You probably never thought about it this way but every time you purchase something, every dollar you spend is going to someone as income, whether it is the workers as wages or benefits, the landlords as rent, a bank that has made a loan as interest income, or to the owners of the business as profits. I tell my students that Real GDP = Real Income and the only question is how that real income is dispersed among owners (profits), workers (employee wages and benefits), lenders (interest), and lessors (rent). Many citizens are unaware that the Government calculates GDP both in terms of the final market value of the goods and services PRODUCED (the “expenditure method”, which is the version that the media uses, as well as how that same production value under the “expenditure method” translates to higher incomes in a GDP version called the “income method”.
I find the preceding paragraph, GDP = Income, to be a break through moment for a lot of citizens, or first time economic students, in truly understanding the value of the GDP measurement. It is easier for most to think in terms percentage growth in income in lieu of a fuzzier wording like GDP percentage growth. Most citizens are surprised to find that our national incomes or GDP, restated for inflation, increased by 17.4% from 2000 – 2007, just prior to the onset of this current recession. This 7-year growth rate in GDP or incomes still equates to a below average historical average performance. More specifically, over the last 7 years our average annual GDP or income growth rate was only 2.2% versus our historical average growth rate of 3.2%. However, the final point of caution is that the GDP or income growth rate is a collective average, thus the growth in GDP or incomes does not indicate how those income gains are accruing to the various socioeconomic classes or professions. That is also a topic of a future blog on “income distribution” or equality.
Discussion Questions:
- Have you ever thought about substituting the word “income” for “GDP” to understand GDP more simply? Why are the concepts of income and GDP inter-changeable?
- Which four groups earn the income generated by the production of goods and services?
- Although GDP has still risen this decade, despite the current severe recession, many analyses show that our nation’s middle class has made virtually no real income gains this decade. How could this be so if GDP = Income and our GDP has grown this decade?
About the author: Mr. Latter teaches various business courses at Paul VI Catholic High School in Fairfax, Virginia (USA) including AP Economics,
Accounting, Marketing, and Personal Finance.
Mr. Latter is a Certified Public Accountant (CPA) and former Chief Financial Officer with 10 years of high school business teaching experience. Prior to his career change to teaching in 2000, Mr. Latter spent 21 years in various auditing, accounting, and financial positions with Price Waterhouse, Sprint, and Teleglobe. Read more posts by this authorRelated posts:
Have you ever thought about substituting the word “income” for “GDP” to understand GDP more simply? Why are the concepts of income and GDP inter-changeable?
Not yet, no. Some of the concepts of income and GDP are interchangeable as changes in purchasing power/income are equal to changed in GDP.
Which four groups earn the income generated by the production of goods and services?
owners, workers, lenders and lessors
Although GDP has still risen this decade, despite the current severe recession, many analyses show that our nation’s middle class has made virtually no real income gains this decade. How could this be so if GDP = Income and our GDP has grown this decade? Because GDP per capita, or the average, is not neccessarily the same as that of the middle: in this case, average has risen whereas the median has remained unchaged for the most part.
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Have you ever thought about substituting the word “income” for “GDP” to understand GDP more simply? Why are the concepts of income and GDP inter-changeable?
No I have never thought about substituting the word "income" for "GDP" to understand GDP more simply, perhaps because those two had never been associated as the same concept in my mind before. These two concepts are so interchangeable because GDP, using the expenditure method, calculates how many final goods are bought and sold, but the money spent in buying goods is income for the sellers of these goods.
Which four groups earn the income generated by the production of goods and services?
The four groups that earn the income generated by the production of goods and services are, workers, lessors, lenders, and entrepreneurs.
Although GDP has still risen this decade, despite the current severe recession, many analyses show that our nation’s middle class has made virtually no real income gains this decade. How could this be so if GDP = Income and our GDP has grown this decade?
This is because yes GDP=INCOME but GDP does not = income distribution. The fact that the middle class has made no income gains means that the growth in income must have gone either to the higher or lower classes of society, excluding the middle class.
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1.Have you ever thought about substituting the word “income” for “GDP” to understand GDP more simply? Why are the concepts of income and GDP inter-changeable?
I have not thought about interchanging the two terms before. They are interchangable because GDP is the money a nation is earning, the money they make from production in the nation, and income is what a person in the nation is earning.
2.Which four groups earn the income generated by the production of goods and services?
The 4 groups that earn income are the workers (labour force), owners (entrepreneurs), lessers (people who rent out land), and lenders (such as the bank).
3.Although GDP has still risen this decade, despite the current severe recession, many analyses show that our nation’s middle class has made virtually no real income gains this decade. How could this be so if GDP = Income and our GDP has grown this decade?
It is possible for GDP to grow but for a certain class not to experience income gain because the income increase for the nation is not necessarily related to every class. The mean (average) income can change, but the median (middle value) income remain the same. For example, if a billionaire moved to a town, her/his income would raise the average income of the twon greatly, however the median income would remain the same.
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1. Have you ever thought about substituting the word “income” for “GDP” to understand GDP more simply? Why are the concepts of income and GDP inter-changeable?
- Yes, as for me it significantly clarifies all the other concepts relating to GDP as well and makes life a lot easier. The concepts are interchangeable because "Real GDP = Real Income", meaning they have the same concepts but have different wording.
2. Which four groups earn the income generated by the production of goods and services?
- "Owners (profits), workers (employee wages and benefits), lenders (interest), and lessors (rent)"
3. Although GDP has still risen this decade, despite the current severe recession, many
analyses show that our nation’s middle class has made virtually no real income gains this decade. How could this be so if GDP = Income and our GDP has grown this decade?
- Even though GDP has risen the hasn't been a change in real income gains in the middle class because although GDP = income the mean isn't the same as the median. So the median can remain the same even if the GDP average increases.
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1. Have you ever thought about substituting the word “income” for “GDP” to understand GDP more simply? Why are the concepts of income and GDP inter-changeable?
I had never thought of substituting the word "income" for "GDP" before. These two concepts are inter-changeable because the GDP stands for the money a nation makes from its production, and the income represents what is earned by households in the nation.
2. Which four groups earn the income generated by the production of goods and services?
The four groups that earn the income generated by the production of goods and services are workers, owners, lenders and lessors.
3. Although GDP has still risen this decade, despite the current severe recession, many analyses show that our nation’s middle class has made virtually no real income gains this decade. How could this be so if GDP = Income and our GDP has grown this decade?
This can happen because an increase in the GDP means that there is an overall increase in the income. However, this does not mean the income increases for everyone and for every working class. Therefore, the income increases might have occurred in the lower and the higher classes, but not the middle class.
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1. Have you ever thought about substituting the word “income” for “GDP” to understand GDP more simply? Why are the concepts of income and GDP inter-changeable?
No I have never thought of substituting the word 'income' for 'GDP' before. They are interchangeable, because they both consider the money made by production or services, may it be of a nation (GDP) or of a single household (income).
2. Which four groups earn the income generated by the production of goods and services?
The four groups that earn income generated by the production of goods and services are workers, owners, lenders and lessors.
3. Although GDP has still risen this decade, despite the current severe recession, many analyses show that our nation’s middle class has made virtually no real income gains this decade. How could this be so if GDP = Income and our GDP has grown this decade?
If the GDP rises this does not automatically indicate that the income of a the middle class will increase as well. Although it may be possible for the income of the higher and lower class to increase. While the GDP increases the median of the income does not but the mean may be able to change.
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1.The thought of exchanging income and GDP doe each other has never occurred to me. However these two concepts can be interchangeable in certain situations. It is possible to interchange them because GDP stands for the money a nations makes from its productions and the income stands for the amount earned by households in a nation.
2. The four groups are worker, owners , lenders and lessors.
3.It is possible for the GDP to increase but for certain classes not to experience an increase of income, this is because a raise in income for the nation does not necessarily relate to ever class. Hence it is possible for the higher and lower classes income to increase but the middle class to see no change in income.
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1. Have you ever thought about substituting the word “income” for “GDP” to understand GDP more simply? Why are the concepts of income and GDP inter-changeable?
I have not thought about substituting income for GDP because I believe that they are inter-changeable. GDP is "monetary measure of the total market value of all final goods and services produced within a country in one year" and income is the what one person of the population is earning.
2. Which four groups earn the income generated by the production of goods and services?
The four groups are the lenders (interest), owners (profits), workers (employee wages and benefits), lessors (rent)
3. Although GDP has still risen this decade, despite the current severe recession, many analyses show that our nation’s middle class has made virtually no real income gains this decade. How could this be so if GDP = Income and our GDP has grown this decade?
It is possible for GDP to increase without increasing the income of the middle class. An increase in GDP means that there is an overall increase in income. The income therefore, does not have to increase for every working class. There might have been an increase in the lower or higher classes.
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1.Have you ever thought about substituting the word “income” for “GDP” to understand GDP more simply? Why are the concepts of income and GDP inter-changeable?
No I have not thought about substituting the word "income" for "GDP" to understand GDP more simply. They are interchangeable because GDP is the money a nation makes from its production and income is what the households nation earns.
2.Which four groups earn the income generated by the production of goods and services?
The four groups that earn the income generated by the production of goods and services are workers, owners, lenders and lessors.
3.Although GDP has still risen this decade, despite the current severe recession, many analyses show that our nation’s middle class has made virtually no real income gains this decade. How could this be so if GDP = Income and our GDP has grown this decade?
GDP represents the overall increase in income and income refers to just the household's income. It is possible that income could increase for certain working classes but not every working class as a whole. The upper and lower class could have gains in income which would lead to an increase in the GDP.
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1. Have you ever thought about substituting the word “income” for “GDP” to understand GDP more simply? Why are the concepts of income and GDP inter-changeable?
-No, it has never occurred to me. But the concepts are interchangeable because GDP is generally the money that circulates within an economy for the finished goods and services produced. However, the production of these goods and services create the households' incomes.
2. Which four groups earn the income generated by the production of goods and services?
-The four groups that earn income generated by the production of goods are the Workers who earn wages and gain benefits, the Owners who earn profit, the Lenders who earn interest and the Lessors who earn payment in the form of rent.
3. Although GDP has still risen this decade, despite the current severe recession, many analyses show that our nation’s middle class has made virtually no real income gains this decade. How could this be so if GDP = Income and our GDP has grown this decade?
-GDP is the representation of the aggregate income of the nation. This generalizes and averages the income of all households, meaning that the upper class may have experiences significant income gains, therefore pushing the GDP up.
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1. Have you ever thought about substituting the word “income” for “GDP” to understand GDP more simply? Why are the concepts of income and GDP inter-changeable?
I have never thought about replacing GDP for income. The concepts are interchangeable because GDP is the total market values of goods and services produced by workers and capital within a nation's borders during a given period, while income is a concept that describes the amount of money earned by households in a nation.
2. Which four groups earn the income generated by the production of goods and services?
The four groups that earn income generated by the production of goods and services are owners, workers, lenders and lessors.
3. Although GDP has still risen this decade, despite the current severe recession, many analyses show that our nation’s middle class has made virtually no real income gains this decade. How could this be so if GDP = Income and our GDP has grown this decade?
The reason our nation's middle class has made virtually no income gains this decade even though our GDP has risen is because GDP is an average that only calculates the national growth of the production of goods and services. GDP does not calculate the income relative to a specific class, so GDP may rise if the middle class income remains constant or decreases and the upper classes income increases.
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1. Have you ever thought about substituting the word “income” for “GDP” to understand GDP more simply? Why are the concepts of income and GDP inter-changeable?
I have never thought about substituting the word "income" for "GDP". However, the concepts of income and GDP are interchangeable because the GDP is a measure of how much money a country makes by the goods that are produced in the nation itself. The money that is earned is the income of some party in the country and therefore both terms can be used.
2. Which four groups earn the income generated by the production of goods and services?
There are four groups that earn the income that is generated by the production of the goods and services. These groups are the workers, the business owners, the lessors and the lenders.
3. Although GDP has still risen this decade, despite the current severe recession, many analyses show that our nation’s middle class has made virtually no real income gains this decade. How could this be so if GDP = Income and our GDP has grown this decade?
The GDP of a nation equals its income. However, these are only an average. If the middle class doesn't earn any income but the GDP still rises, this means that either the lower or the upper class are earning much bigger incomes a year which then pulls up the GDP for the entire nation. If you were living in a neighborhood were everyone earned $1 and somebody who earned $100 would move to this neighborhood, the mean income would increase but the median income would still be $1.
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